Samuelson: Are tax breaks immortal?

Tuesday

Nov 14, 2017 at 12:01 AM

Robert Samuelson

If you want to understand why the tax code is so hard to overhaul, consider the case of the mortgage interest deduction.

To its many defenders and beneficiaries, the mortgage interest deduction symbolizes and subsidizes the American Dream. It promotes home ownership, which gives people a stake in stronger neighborhoods and safer streets.

By allowing homeowners to write off their mortgage interest expenses, thus reducing their taxes, the government purportedly encourages these good things. The cost in lost tax revenue is considered money well spent. In 2017, that would be $64 billion, according to the Office of Management and Budget.

Case closed? Not exactly. For years, many economists have argued that the standard narrative about the deduction is mostly a self-serving fairy tale. The reality is that the subsidy promotes oversized homes and higher real-estate prices. Upper-middle-class households are the main users of the deduction, which barely raises home ownership rates, if at all.

"People are being bribed by the government to buy exceptionally big homes," says economist Jonathan Gruber of the Massachusetts Institute of Technology. In effect, there's a subsidy for McMansions.

Gruber recently did a study with economists Henrik Kleven of Princeton and Amalie Jensen of the University of Copenhagen. Like the United States, Denmark has a mortgage interest deduction. In 1987, the Danes reduced the deduction's generosity. Home ownership did not diminish. This stability suggests that factors other than sheer economics — culture, psychology, geography — influence home ownership. What did decline was the size of homes and the amount of debt people assumed.

The same dynamic applies to the United States, Gruber says. For decades, the home ownership rate has hovered around 64 percent. It spurted briefly to nearly 70 percent during the housing "bubble" of this century's first decade, but has reverted to 64 percent.

Reducing or eliminating the deduction could encourage less debt, giving people extra cash to save for retirement, pay for children's college or cover daily expenses. It's a compelling case.

But the messy reality is that, regardless of its actual impact on the economy and personal housing decisions, millions of Americans believe they benefit from the deduction.

Start with 76 million homeowners. If, as many economists think, the deduction props up real estate prices, then removing the deduction likely would weaken prices. This would help first-time buyers or those moving to bigger homes. But it would hurt home sellers.

Next, consider that about 34 million taxpayers take the mortgage interest deduction, according to the Congressional Joint Committee on Taxation. Although that's only about a fifth of all tax filers, they're concentrated in the upper middle class. They're bound to fear its loss will not be compensated by other tax reductions.

Finally, there are all the businesses that depend on housing: builders, real estate agents, mortgage brokers, furniture and appliance companies. They have a stake in larger homes. Think higher prices, fatter real estate commissions, bigger mortgages and more construction.

Against this backdrop, it's not surprising that the House and Senate deal with the mortgage interest deduction differently. Although phasing out the deduction would be the best policy, the proposal before the Senate Finance Committee would preserve the status quo. In effect: Don't disturb this political hornet's nest. Meanwhile, the House proposal would reduce the subsidy by allowing the interest deduction only on loans up to $500,000, a 50 percent decline.

Just how these opposite proposals can be reconciled is anyone's guess. But there is a larger point.

No matter how dubious or outmoded, tax breaks work themselves into the nation's economic and social fabric. They are hard to unravel.

Robert Samuelson writes on economic issues for The Washington Post.

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